Lego’s business model innovation

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Lego’s business model innovation

Lego, headquartered in Billund, Denmark, is currently the world’s second largest toy producer with 10,000+ employees worldwide, and 2012 sales of approximately 4,5 billion USD and profits of about a billion USD. Though not a big company internationally it has no doubt exhibited a high performance over the last decade growing from a position as the seventh largest toy producer to the second place in a stagnant industry.

It hasn’t always been like this. In 2004 the company was in fact on the verge of bankruptcy, arguably as a result of an overly ambitious diversification strategy. Partly prompted by the expiration of the basic Lego brick patent in 1983, the company had diversified into theme parks, merchandise, and products that essentially had little to do with the emphasis on construction and creative play that had been core values since the inception of the company. This had been accompanied by a strategy of pursuing a high degree of vertical integration.

Massive losses and decline in sales towards the end of 2004 led to the dismissal of the CEO and the appointment of a new CEO. With a PhD in business administration and serving as the manager of Lego’s internal strategic planning unit, Jørgen Vig Knudstorp who was a peripheral insider with strong analytical capabilities. Over the coming years he essentially innovated the Lego business model in four key dimensions.

First, Knudstorp trimmed the product offering and the number of inputs entering into Lego products. He then restructured the supply chain in terms of engaging in substantial outsourcing and offshoring. Company boundaries were also changed by making by opening up to customers and users by creating user communities, super-users (“Lego Certified Professionals”) and engaging in joint new product development efforts with major customers, such as Wal Mart and Toys ‘R’ Us. Stepping up the digitalization content of both operations and products supported the above changes.

With the benefit of hindsight, the restructuring of LEGO may appear to be straight-forward and the logical thing to do. However, the successful re-invention of LEGO’s required exceptional leadership skills and changes in the company’s organization design – its reward systems, lines of communication and decision-making, and coordination architecture – to search for and implement a new ways of creating and capturing value.

Many distinctly organizational challenges emerged. For example, trimming the number of components in the production process from 12,700 (supplied by 11,000 suppliers!!) to 6,000 involved a massive centralization of purchasing decisions. The number of components had grown to such heights because engineers were free to set up purchasing arrangements with basically any firm. They disliked having such rights taken away. Opening up towards users and customers was initially looked at with suspicion by people in product development. Concerns were raised whether something as physical as the core product, the brick, could be taken into a digital universe.

While the changes to the Lego business model were carried out sequentially, there were many linkages between these changes. For example, creative construction is the Lego core value. Creative construction was strengthened by the increased emphasis on digitalization, which also allowed the company to reach new segments (gaming teenagers). Selling off theme parks slashed costs and led to savings that could be partly deployed to product development. Such interlocking changes needed management.

Recently, Lego has expanded its top-management team from 6 to almost twenty members in an effort to improve the coordination of the company’s ongoing experimentation with and refinement of its business model. Leadership and organizational design matter precisely because the system needs to be redesigned, whether incrementally or more radically.